Wednesday, March 04, 2015

Staff Issues Guidance on Volcker Rule’s Covered Fund Exemption

Commissioner Kara Stein last month spoke in Tokyo, Japan, about the changes the Dodd-Frank Act’s Volcker rule brought to the U.S financial system. In written remarks, which were recently posted by the SEC, Stein spoke about the rule’s value for enhancing systemic resilience and its broad global coverage. While Japan’s banks did not need a bailout in the 2008 financial crisis, Stein said its economy was affected by the global recession.

Stein’s guidance recommendation. The Volcker rule is in the process of being implemented and Stein recognized the need for meaningful guidance and responses to questions in a timely and transparent manner. Regulators cannot answer every question, she said, but that is no reason to delay the implementation of the rule. She recommended that the Volcker rule working group establish a deadline for responding or choosing not to respond to a question. She said it would be helpful for everyone to know the types of questions that are being asked before they are answered. Providing clarity and transparency around the guidance process will help the industry comply while also speeding up the effective implementation of this important financial reform.

Staff FAQ. The SEC’s Division of Trading and Markets, on February 27, updated its guidance under Section 13 of the Bank Holding Company Act, known as the Volcker rule, as it relates to the exemption for hedge fund or private equity fund activities that occur solely outside the U.S. (SOTUS). The guidance responds to whether the marketing restriction under the rule applies only to the activities of a foreign banking entity that is seeking to rely on the SOTUS covered fund exemption or whether it applies more generally to the activities of any person offering or selling ownership interests in a covered fund. According to the guidance, the regulatory agencies believe the marketing restriction applies to the activities of a foreign banking entity, including its affiliates, which seek to rely on the SOTUS covered fund exemption.

Marketing restriction. The marketing restriction provides that no ownership interest in a covered fund will be offered or sold to a resident of the U.S. –that is, the offer does not target U.S. residents. The staff notes that the marketing restriction constrains the foreign banking entity in connection with its own activities with respect to covered funds, which ensures that in seeking to rely on the SOTUS covered fund exemption, it does not engage in an offering of ownership interests that targets residents of the U.S.

If the marketing restriction were applied to the activities of third parties, the staff explained, such as the sponsor of a third-party covered fund, the SOTUS covered fund exemption may not be available in certain circumstances, such as where the risks and activities of the foreign banking entity with respect to its investment in the covered fund are solely outside the U.S.

A foreign banking entity or its affiliates that seek to rely on the SOTUS covered fund exemption must comply with all of the conditions of the exemption, including the marketing restriction. A foreign banking entity that participates in an offer or sale of covered fund interests to a resident of the U.S. cannot rely on the SOTUS covered fund exemption with respect to that covered fund.

The staff added that, where a banking entity sponsors or serves, directly or indirectly, as the investment manager, investment adviser, commodity pool operator, or commodity trading adviser to a covered fund, that banking entity will be viewed as participating in an offer or sale of the covered fund ownership interests. Accordingly, the foreign bank entity would not qualify for the SOTUS covered fund exemption if that covered fund offers or sells ownership interests to a resident of the U.S.